Multi-assetMay 31 2013

Investment insight: Risk-rated funds

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Risk management is becoming increasingly important to advisers given the nature of the markets in the past few years.

Today, traditional ‘safe haven’ investments like gilts are struggling to keep pace with inflation, leaving advisers with the arduous task of finding decent returns that match a client’s tolerance for risk.

To help lighten the burden, outsourcing tools like risk-rated funds were launched to give advisers a helping hand in their search for a client solution. As the name suggests, each fund is rated according to the risk it takes, ranging from lower risk and lower volatility to higher risk and higher volatility.

These funds are typically marketed with a description such as ‘balanced’, ‘cautious’ or ‘growth’. Alternatively, they are assigned a numerical value that matches risk levels set by a third-party risk-rating company, such as BITA Risk or Distribution Technology. Once an adviser has reviewed a client’s finances and appetite for risk, a suitable risk-rated fund can then be assigned.

RDR solutions

While outsourcing risk management investments has its appeal, the sector as a whole is rather more complex. The introduction of the RDR produced plenty of talk on the added pressures faced by advisers to find suitable investments at a low cost, which increased the desirability of outsourcing aspects of investment decisions to external experts to save time and money.

But with there being no such thing as a perfect pre-packaged solution given clients have vastly different investment expectations, fears have been raised about the consistency of risk-measuring strategies and their all-round suitability.

In January, former watchdog the FSA announced plans to clamp down on risk-rated funds amid fears that advisers were relying too much on third-party risk ratings without carefully scrutinising each provider’s criteria. These calls were followed in April by the regulator’s predecessor, the FCA, which voiced its concerns about the lack of consistency between products, (although it was encouraged by improvements made to analysis tools).

Says who?

Detractors of risk-rated funds have long claimed these vehicles are oversimplified. Because there is no standard measure for risk, the same fund can be given different ratings depending on which system is used. This level of subjectivity has attracted plenty of criticism, particularly as definitions of risk can vary greatly depending on past experience and perception of investments.

As a result, the differences between funds with similar rating levels can vary significantly. Chart 1, for example, shows the current asset allocation of the lowest risk fund profiles offered by F&C and Old Mutual.